Chrysler deal hits tougher loan market

Investors push back ahead of a record $250 bln in borrowing for big buyouts

By

AlistairBarr

SAN FRANCISCO (MarketWatch) -- Private-equity giant Cerberus Capital Management LP is borrowing billions for its Chrysler Group acquisition just when the buyout tide has begun to ebb, according to credit market experts.

A shift in investor sentiment could make future LBOs more expensive, possibly quelling the buyout boom that's been one of the biggest drivers of stock-market gains.

The Chrysler deal comes at a time when a record $250 billion of leveraged loans and $50 billion of high-yield debt needs to be issued, with a big chunk of that borrowing being used to pay for other huge buyouts of companies, including TXU Corp.
TXU
First Data Corp.
FDC, +0.31%
and Alltel Corp.
AT, +0.96%

A year ago, this so-called forward calendar totaled less than $70 billion, according to credit agency Fitch Ratings.

This $300 billion overhang has begun to change the dynamic of the LBO financing environment in favor of investors and against private-equity firms and their buyout targets.

Earlier this year, investors searching for higher yields battled to invest in loans backing buyouts. That encouraged the growth of so-called covenant-lite loans, which give companies more leeway and creditors less power. But with so many big buyouts needing financing, investors are now pushing back by demanding more covenants and higher spreads.

"It's a concern, given the large amount of paper coming," said Bradley Kane, portfolio manager at SCM Advisors LLC, a $14 billion San Francisco-based investment firm specializing in fixed-income markets. "Deals will need to come with wider spreads and more covenants."

More covenants on the loans supporting Cerberus' Chrysler buyout "would be good credit enhancement from our perspective," Kane added. "But we always like more covenants."

A Cerberus spokeswoman declined to comment Monday. Representatives at J.P. Morgan Chase
JPM, -0.36%
Goldman Sachs
GS, -0.58%
and Citigroup
C, -0.62%
which are leading the underwriting of the debt, also declined to comment.

"The market is demanding more for the risks it takes on," Vanessa Spiro, bank finance partner at law firm Jones Day, said. "As pricing increases and it becomes more expensive to support deals, that could put a strain on the type of transactions that can be done."

One measure of investors' risk appetite -- the Merrill Lynch U.S. High Yield Master II Index, a broad-based index that tracks high-yield bonds -- shows how quickly things have changed.

The option-adjusted spread on the index stood at 316 basis points over U.S. Treasury bonds late last week. In early June, the spread was 241, according to Eric Tutterow, a managing director at Fitch.

"That's a 31% increase in a month, which really shows you the risk premium that investors are willing to take on now," he said. "There's a concern that we could be getting into a situation in which banks could begin pulling back credit."

Pulled deals, hung loans

Such turmoil has already derailed some debt offerings, delayed some buyouts or made them more expensive.

The sale of more than $3 billion in loans and bonds to pay for part of the buyout of US Foodservice was postponed indefinitely last month, Tutterow said.

Financing for the Thomson Learning LBO had to be re-priced and some parts were dropped altogether, he added.

When investment banks arrange financing for LBOs, they usually provide a bridge loan to help the deal close quickly. They then sell the debt in the market. When LBO financing stalls or fails, these banks are left with so-called hung loans.

"That means some banks are holding very expensive debt on their balance sheets right now," Spiro said.

Other deals are being delayed. Financing for the First Data LBO has been put back to September, according to the Wall Street Journal.

"The market is more crowded and it's softened, so people are moving more slowly because they don't want to push too many deals through the gate at the same time," said Steven Miller, managing director of Standard & Poor's Leveraged Commentary & Data.

Shaky

Other buyouts also look shaky or have failed. That's sometimes been for other reasons, but such disruptions worry leveraged loan investors.

A leveraged loan that was sold in May to pay for part of Sam Zell's Tribune Co.
TRB, -14.29%
acquisition originally traded at 99 cents on the dollar. On Monday morning, the deal was trading at 95.25, according to two investors who didn't want to be identified.

The poor performance has been driven partly by a bigger-than-expected drop in sales, the investors explained.

In May, Tribune's publishing ad revenues were down almost 12% on continuing weakness in classifieds and a nearly 18% decline in national ads. Meanwhile, circulation revenue fell 6.2% and broadcasting revenue slumped 11%.

The Tribune acquisition is a two-part deal, so such problems have sparked concern that the transaction could fail. See full story.

Chrysler deal

Amid these market disruptions, the banks selling the debt to support Cerberus' acquisition of Chrysler have been running road shows to attract investors.

Cerberus agreed to buy 80% of Chrysler from DaimlerChrysler
DCX
on May 14 and is investing $7.4 billion in the company's main auto business and its financing unit. See full story.

Cerberus is borrowing $12 billion for Chrysler's auto business and $8 billion for the finance division. More than $30 billion is also being borrowed via the asset-backed securities market to refinance auto loans.

In late June, a $10 billion first-lien loan to support the auto unit was being priced at 325 basis points over the London Interbank Offered Rate (Libor), according to S&P Leveraged Commentary & Data. A $2 billion, second-lien loan was priced at 600 basis points over Libor.

The banks selling the loans are now considering increasing the pricing. The first-lien loan may now be priced at 375 basis points above Libor, S&P Leveraged Commentary & Data reported on Tuesday. A Thursday deadline for investors to sign up for the deal will likely slip into next week, the report added.

Last week, Cerberus Chairman and former Treasury Secretary John Snow rebuffed speculation that the deal was struggling, during an interview on CNBC.

"Strong financing is in place and we're going to go forward. I don't know where those rumors come from," he said. "We're not going to re-negotiate the deal here. We're confident of the financing. It will be closed in the third quarter."

That hasn't convinced some leveraged loan experts.

"I'm sure the financing's in place, but what that means is that the lead underwriters have signed up to provide bridge financing and are committed," Fitch's Tutterow said. "They now have to sell it into the market."

"Some say it will be a tough struggle," he said on Friday. "Others think that given the brand of the sponsor, the deal will get done. Right now the jury's really out."

The loans backed Chrysler's auto unit could be sold at a discount of roughly 98 cents on the dollar, S&P Leveraged Commentary & Data reported on Tuesday.

That would leave the underwriting banks, led by J.P. Morgan, Goldman and Citigroup, sucking up the difference, Miller explained.

Loans to pay for the LBO of Dollar General
DG, +0.57%
were sold at 97 cents on the dollar recently, Miller noted.

Likely to succeed

While the Chrysler LBO financing and other deals are likely to be re-priced and changed in other ways to favor investors, there's no major liquidity crisis looming, Miller and others said.

That's mainly because corporate debt defaults are at record lows, Miller explained.

When the last LBO boom ended at the start of the 1990s, defaults on high-yield debt were much higher and many companies filed for bankruptcy, Spiro recalls. That made banks nervous and they extended fewer loans, she explained.

"So far, there's no crisis of confidence like that," Spiro said. "Recent disruptions will probably result in refinements of structures and increases in pricing."

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